ROE: Return on Equity or Return on Ego?

ROE is off-course Return on Equity that measures returns generated on shareholders wealth and companies across sectors try hard to maximize it. But as far as Hotel Industry in India is concerned it seems ROE is certainly Return on Ego as the promoters of most of the hotel companies in India went on to expand on leverage and at any cost without considering the return economics in mind. This is primarily due to the fact that there is a certain aspiration and glamour around hotels, especially in the high-end luxury segment, and many developers get in the race to build grand properties rather than one that will give them the best financial return.

The consequence is that the hotel stocks in India are the worst performing stocks in past 5 years and there is no ray hope in sight yet. Occupancy and Average Room Rates are consistently under pressure and is expected to remain under pressure over short to medium term. The average occupancy in the industry fell from 71.5 per cent in FY06 to 59.1 per cent in FY12. The average room rate for a five-star deluxe room was down to Rs 9,192 in FY12 from Rs 11,200 per night in FY08. With inflation in double digits, for the hotels it has meant low profit margins and poor return ratios.

Hotel Leela which used to be one of the favorite hotel stocks is reeling under debt:equity ratio pressure of more than 2.5 times. Not only that, the aspiration of some companies to buy hotels abroad at lofty valuation have dented the home balance sheet in a significant way. For instance, Indian Hotels' acquisition of 11 per cent stake in Oriental Express Hotels at an average price of $42 per share in 2007 is now worth a quarter. The company also acquired a series of properties in the US and the UK, most of which are still to yield returns.

In general these stock may look cheap in absolute term but they should be completely avoided for next 2-3 years until the demand matches up to the supply. However one can look at hotel stocks which are less levered and are current generating healthy ROEquities and not ROEgos.